MerchantFX Reversal Patterns

Reversal Patterns

JAPENESE CANDLESTICKS
Every candlestick pattern has four sets of data that help to define its shape.
Analysts are able to make assumptions about price behaviour based on the
shape.
Each candlestick is based on an open, high, low and close.
The time period or tick interval used does not matter.
The filled or hollow bar created by the candlestick pattern is called the
body.
The lines that extend out of the body are called shadows.
An instrument that closes higher than its opening will have a hollow or
green candlestick.
If the instrument closes lower, the body will have a filled or red candlestick.

Technical
Analysis
Japanese Candles

DOJI
One of the most important candlestick formations is
called the Doji.
Doji, referring to both singular and plural form, is created
when the open and close price is virtually the same.
Doji tend to look like a cross or plus sign and have small
or non-existent bodies.
From an auction theory perspective Doji represent
indecision on the side of both buyers and sellers.
Everyone is equally matched, so the price goes nowhere;
buyers and sellers are in a standoff.
Analysts interpret this as a sign of reversal. However, it
may also be a time when buyers or sellers are gaining
momentum for a continuation trend.
Doji are commonly seen in periods of consolidation and
can help analysts identify potential price breakouts.
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LONG-LEGGED DOJI
The Long-legged Doji is composed of long upper and lower shadows.
FORMATION: Throughout the time period, the price moved up and down dramatically before it
closed at or very near the opening price. This reflects the great indecision that exists between
the bulls and the bears.
SIGNAL: Bearish trend traders look to enter the market after a Long-Legged Doji closes and are
best used on wider timeframes like the daily chart.
DRAGONFLY DOJI
A candle that is formed when the open and closing prices are equal to, or near, the high of the
candle.
FORMATION: Bears begin to sell causing the price to fall. Bullish buyers begin to buy causing the
price to increase.
SIGNAL: If the Dragonfly Doji is found in an downtrend, it may signal a bullish trend reversal when
confirmed by a subsequent bullish candle.
GRAVESTONE DOJI
A candle that is formed when the open and closing prices are equal to, or near, the high of the
candle
FORMATION: Bulls begin to buy causing the price a rally. Bears begin selling causing the price to
decrease.
SIGNAL: If the Gravestone Doji is found in an uptrend, it may signal a bearish trend reversal if
confirmed by a bearish decision candle.

Spinning Top
Bulls and Bears struggle to take control of the price.
The shadows above and below the real body suggests
price action, but the small real body reflects the fact that
there was no real winner in the battle.
The colour of the Spinning Top is irrelevant.
The Spinning Top is a signal of indecision.
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Bullish & Bearish Spinning Top
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Spinning Top
Candlestick lines that have small bodies with upper and lower
shadows that exceed the length of the body. Spinning tops signal
indecision.

Engulfing
An engulfing pattern signals a reversal, and can be
bullish or bearish. It comprises two candles. The
body of the second must engulf the body of the
first, and must be the opposite colour to the first.
For a bullish engulfing candle, we have a smaller
red candlestick, followed by a green candlestick,
the body of which is greater in size that the
previous candle.
For a bearish engulfing candle, the first candlestick
is smaller and green, followed by a red candlestick,
the body of which engulfs the previous candle.
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The Hammer & The Hanging Man
The Hammer
FORMATION: In a downtrend, the sellers push the price to a
level where the buyers step in and begin to lift the price higher.
SIGNAL: If the Hammer is found in an extended downtrend, it
may signal a bullish trend reversal when confirmed by a
subsequent bullish decision candle.
The Hanging Man
FORMATION: In an uptrend, the sellers attempt to gain control of
price by pushing the price down, but the bulls are able to step in
and lift the price higher once again.
SIGNAL: The Hanging Man signals vulnerability to bearish
pressure. For this reason the Hanging Man is a signal of a bearish
reversal if confirmed by a subsequent bearish decision candle.

Inverted Hammer & Shooting Star
These candles are identified by having very small real bodies with little or no shadow to the south, and a
long shadow to the north. The shape of these formations are the same, but it is the location in the trend
that determines whether the formation is a Shooting Star (Bearish) or an Inverted Hammer (Bullish).
Inverted Hammers and Shooting Stars can have green or red
bodies – what’s important here is that the body size is small, that
the upper wick is at least twice the length of the body, and the
lower wick is negligible.
Inverted Hammer
A one-day bullish reversal pattern. In a downtrend, the open is
lower, then it trades higher, but closes near its open, therefore
looking like an inverted lollipop.
Shooting Star
A single day pattern that can appear in an uptrend. It opens
higher, trades much higher, then closes near its open. It looks just
like the Inverted Hammer except that it is bearish.
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Three Soldiers & Three Crows
Three White Soldiers
A bullish reversal pattern consisting of three consecutive
long green or white bodies. Each should open within the
previous body and the close should be near the high of the
day.
Three Black Crows
A bearish reversal pattern consisting of three consecutive
long red or black bodies where each day closes at or near
its low and opens within the body of the previous day.
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Double Top
The double top is a frequent price formation at the end of a bull
market.
It appears as two consecutive peaks of approximately the same
price on a price-versus-time chart of a market.
The two peaks are separated by a minimum in price, a valley.
The price level of this minimum is called the neck line of the
formation.
The formation is completed and confirmed when the price falls
below the neck line, indicating that further price decline is imminent
or highly likely.
The double top pattern shows that demand is outpacing supply
(buyers predominate) up to the first top, causing prices to rise.
The supply-demand balance then reverses; supply outpaces
demand (sellers predominate), causing prices to fall.
After a price valley, buyers again predominate, and prices rise.
If traders see that prices are not pushing past their level at the first
top, sellers may again prevail, lowering prices and causing a double
top to form.
It is generally regarded as a bearish signal if prices drop below the
neck line.

Double Top
The time between the two peaks is also a determining factor for
the existence of a double top pattern. If the tops appear at the
same level but are very close in time, then the probability is high
that they are part of the consolidation and the trend will resume.
Volume is another indicator for interpreting this formation. Price
reaches the first peak on increased volume then falls down the
valley with low volume. Another attempt on the rally up to the
second peak should be on a lower volume.

Double Bottom
Confirming a Double Bottom Chart Pattern
The double bottom pattern always follows a major or minor down trend in a
particular security, and signals the reversal and the beginning of a potential
uptrend.
Consequently, the pattern should be validated by market fundamentals for the
security itself, as well as the sector that the security belongs to, and the market in
general.
The fundamentals should reflect the characteristics of an upcoming reversal in
market conditions.
Also, volume should be closely monitored during the formation of the pattern.
A spike in volume typically occurs during the two upward price movements in the
pattern.
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These spikes in volume are a strong indication of upward price pressure and serve
as further confirmation of a successful double bottom pattern.

There is way more to understanding candlestick patterns than
just identifying them it’s about what is going to happen next?
Knowing what is in front of you on the charts, understanding price action, the trend and volatility of the asset class will
put you in the best position possible as the opportunity arises!
BULLS VS BEARS Every candlestick is a battle of the buyers against the sellers. From candlesticks we can see the data
of who is in control who is pulling back.
What will happen next?
“I can’t emphasize enough that we should always look at the bigger picture. a single candlestick alone is not enough.
PAST TRENDS? KEY LEVELS ? PARAMETERS? HIGHS? LOWS? FORMATIONS?”
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Head and Shoulders
A Head and Shoulders reversal pattern forms
after an uptrend, and its completion marks a trend
reversal. The pattern contains three successive
peaks with the middle peak (head) being the
highest and the two outside peaks (shoulders)
being low and roughly equal. The reaction lows of
each peak can be connected to form support, or a
neckline.
Inverted Head and Shoulders
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Prior Trend: It is important to establish the existence of a prior uptrend for this to be a reversal pattern. Without a prior uptrend to reverse, there
cannot be a Head and Shoulders reversal pattern (or any reversal pattern for that matter).
Left Shoulder: While in an uptrend, the left shoulder forms a peak that marks the high point of the current trend. After making this peak, a
decline ensues to complete the formation of the shoulder The low of the decline usually remains above the trend line, keeping the uptrend
intact.
Head: From the low of the left shoulder, an advance begins that exceeds the previous high and marks the top of the head. After peaking, the
low of the subsequent decline marks the second point of the neckline. The low of the decline usually breaks the uptrend line, putting the
uptrend in jeopardy.
Right Shoulder: The advance from the low of the head forms the right shoulder. This peak is lower than the head (a lower high) and usually in
line with the high of the left shoulder. While symmetry is preferred, sometimes the shoulders can be out of whack. The decline from the peak of
the right shoulder should break the neckline.
Neckline: The neckline forms by connecting low points 1 and 2. Low point 1 marks the end of the left shoulder and the beginning of the head.
Low point 2 marks the end of the head and the beginning of the right shoulder. Depending on the relationship between the two low points, the
neckline can slope up, slope down or be horizontal. The slope of the neckline will affect the pattern's degree of bearishness - a downward slope
is more bearish than an upward slope. Sometimes more than one low point can be used to form the neckline.
Support Turned Resistance: Once support is broken, it is common for this same support level to turn into resistance. Sometimes, but certainly
not always, the price will return to the support break, and offer a second chance to sell.
Price Target: After breaking neckline support, the projected price decline is found by measuring the distance from the neckline to the top of the
head. This distance is then subtracted from the neckline to reach a price target. Any price target should serve as a rough guide, and other
factors should be considered as well. These factors might include previous support levels, Fibonacci retracements, or long-term moving
averages

Morning Star
A three-day bullish reversal pattern
consisting of three candlesticks - a longbodied
black candle extending the
current downtrend, a short middle
candle that gapped down on the open,
and a long-bodied white candle that
gapped up on the open and closed
above the midpoint of the body of the
first day.
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Evening Star
Evening Star
A bearish reversal pattern that continues an
uptrend with a long white body day followed by a
gapped up small body day, then a down close with
the close below the midpoint of the first day
Evening Doji Star
A three-day bearish reversal pattern similar to the
Evening Star. The uptrend continues with a large
white body. The next day opens higher, trades in a
small range, then closes at its open (Doji). The next
day closes below the midpoint of the body of the
first day.
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Questions to ask yourself while
you do the analysis?
THE CURRENT CANDLE:
The size of the body?
The candle body is a great starting point because we can get a lot of information from it. A long body is showing strength
when bodies become larger it shows momentum . When bodies become smaller, it shows slowing momentum. The body
shows the range over the duration of the candle .
Larger or smaller than the previous ones? Is the size changing meaningful or not?
Is the change happening during an inactive trading period?
For example, candlesticks on EUR pairs they tend to shrink in size during the quieter Asian session.
The length of wicks?
Wicks can show the volatility of price movements. Larger wicks show that price has moved a lot during the duration of
the candle, but it got rejected. When candle wicks become larger it shows an increase in volatility. This often happens
after long trending phases before a reversal happens. Or at major support and resistance levels.

Continued
The ratio between wicks and bodies do you see longer wicks or bodies?
In a high momentum trend, you can often see long bodies with small wicks. When uncertainty
rises, the volatility picks up and bodies become smaller while wicks become larger. The position
of the body this is an extension of the previous point.
Can you see a long wick with a body on the opposite side?
This is often showing a rejection When you have a small body in the middle of a candle with long
wicks, it means indecision
You can see that once we start combining the information that wicks and bodies provide, we can
practically analyse all candlestick formations
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